The Money Spy website

Welcome to The Money Spy....This is where we will be posting articles, latest news updates, opinions, prompting discussions or just about anything interesting related to finance. If you would like to contact us then call 01892 506970 or email info@themoneyspy.net

If 10cc were to write a song about the latest surveys on the UK economy they might say: “I don’t like surveys. Oh no, I love them.” The fact is that the surveys are not just good; they are remarkable, but can they really be right?

It was told here on Tuesday how the latest Purchasing Managers’ Indices (PMIs) on UK manufacturing and construction were pretty darned impressive. The last index tracking manufacturers’ output and another for new orders, both produced by Markit/CIPS each rose to their highest level since 1994. Another index, this time tracking construction, rose to its highest level since 2007.

Then yesterday came the PMI for services, and a composite index which combines the PMI readings for manufacturing, construction and services. The PMI for services rose to its second highest level in the 15 year history of the index – the record was set in December 2006.

As for the composite PMI, this rose to 60.7. Now you might say 60.7 what? Well to put this reading in context, any score over 50 is meant to be consistent with growth. And the 60.7 reading just happens to have been the highest reading ever recorded during the 15 years that these composite indices have been produced.

So what does this mean? Markit reckons its surveys points to growth in Q3 of between 1 and 1.3 per cent compared to Q2.

Also this week, the OECD was busy revising upwards. It is one of those strange-but-true quirks that forecasters tend to revise their predictions downwards when we enter a downturn, and revise upwards when we exit. The OECD is now predicting that the UK economy will expand by 3.7 per cent in Q3 on an annualised basis. Incidentally, if its forecasts are right the UK will be the fastest growing economy across the G7 in the second half of this year. But if the PMI indices are right, the OECD will in fact be understating the truth.

So far then it is all good stuff.

Can it last? It is clear that the Help to Buy Scheme has helped to buy the UK economy more growth. The danger remains, however, that the chancellor is creating growth from a new housing bubble. The Bank of England dismisses this, but do members of the MPC, for all their cleverness, understand the British psyche, and how prone it is to getting behind housing booms, even when they are built on smoke, mirrors and the naive belief that interest rates will stay at near record lows for the 25 years during which they still have a mortgage.

But there are reasons for hope, however. Take for example the news that Nissan is creating 1,000 new jobs, as it expands its factory in Sunderland – a car factory by the way that some people claim is the most efficient in the world.

Or take UK trade. Since the end of 2011, UK imports have grown by 5 per cent and exports by 6 per cent. According to the ONS, UK exports to the BRICS countries as a percentage of total UK exports have increased from 2.6 per cent to 9.1 per cent over the last 15 years. 6.0 percentage points of this rise have occurred since 2006. Okay imports have risen too, but in the last couple of years UK exports growth to the BRICS has outstripped import growth to those same countries.

It is just a shame the chancellor cannot put the same level of commitment into what we might call a Help for Business Scheme as he has put into the housing market.

Is it for real? We keep hearing talk of an export-led recovery for the UK. But is it simply that the UK exports are so low that any rise looks to be quite significant in percentage terms. A new report from Ernst and Young provides just a hint that this time it might be for real.

UK companies need to look abroad. The last few years have seen UK consumers cutting back, and that, suggests Ernst and Young, is why they have been focusing on ways to increase exports.

The story overall? Well, let’s return to that in a moment. Let’s start with the positive.

According to Ernst and Young, the West Midlands “is emerging as an export powerhouse” and “is on track to grow goods exports faster than any other UK region by selling high-end engineering far outside Europe.” Engineering goods exports are forecast to grow at “an annualised rate of 4.8 per cent, worth £6.9 billion in 2017, compared with £5.5 billion in 2012.”

UK automotive exports to China are expected to grow 11.6 per cent – making it the UK’s top automotive trading partner by 2017, while exports of personal vehicles to Thailand are expected to rise from $302 million in 2012, to $617 million by 2017. The UK is expected to capture a 53 per cent share of the entire import market. UK engineering is also seeing exports rise to the Middle East – with growth in turbo jet exports to Qatar alone forecast to grow from $273 million in 2012 to $481 million in 2017. And finally, UK biopharma exports to China are expected to double from $52 million in 2012 to $104 million by 2017, with Chinese biopharma imports set to rise to $2.5 billion by 2017 (from $1.4 billion in 2012).

Break it down bit further, and Ernst and Young forecasts that in 2017, UK engineering exports to China will be worth $2.4 billion, automobile exports $3.8 billion and metals $2.1 billion. For Brazil, it forecasts $0.7 billion for engineering, $0.6 billion for automobiles and $0.6 billion for chemicals. For Hong Kong it forecasts engineering exports of $1.7 billion, $1.4 billion for electronics, and $1.3 billion for previous metals. And for Saudi Arabia it forecasts engineering exports of $0.9 billion, $0.4 for electronics and $0.4 for pharmaceuticals.

And yet for all that, Ernst and Young says that across the UK exports are not growing fast enough. It forecast 0.3 per cent annual growth for UK good exports against 1 per cent for the European average between now and 2017. So for the conclusion: making progress, but could do better.

There is good and bad side to a currency falling in value. A cheaper currency is bad news for importers. It is bad news for consumers who want to pay as little as possible for the goods they buy, and for their holidays abroad. A falling currency can be bad news for inflation. But there is a flipside. It can at least hand exporters a massive terms of trade advantage. A country that needs to see exporters drive growth surely needs a cheaper currency. So why is it that the UK seems to have the bad side, but very little of the good side? A new report seems to provide an answer.

Between Q3 2007 and Q1 2009 the effective exchange rate of the pound fell 25 per cent. Inflation rose. Wage inflation didn’t, which left workers worse off. But the UK’s balance of trade in goods and services was largely unchanged. Why didn’t exports rise?

The Office of National Statistics has come up with four possible explanations.

Number one: Global supply chains. The argument runs like this: global trade has become so integrated, with supply chains being so closely in alignment, that it is very hard for a country that sits in a supply chain to suddenly start selling more goods just because prices have fallen. The ONS put it this way: “If multinational companies have an international supply chain structure, which involves moving goods and services between a number of countries before a final product is produced, it is difficult to change this structure in the short term in response to an exchange rate movement.”

Number two: Financial shock and composition of trade. This is a nice simple argument. The UK relies on financial services. In the aftermath of the 2008 crisis, financial services took the biggest hit, therefore UK imports were adversely affected.

Number three: Price effects. The ONS put it this way: “Domestic exporters – whose goods are relatively less expensive as a result of the depreciation – may choose to increase profit margins on sales to overseas customers, rather than passing on the full benefits of the exchange rate change.” There was another factor: oil. As the pound fell, the price of oil hit UK exporters.

Number four: Effect of downturn on main trading partners. This was surely the main problem for the UK. Sure, the pound was cheap, but our main trading partners – the US and the Eurozone – were in recession or even depression for many of the last few years.

So what can we take from all this, and say about what will happen to the UK next?

It does seem that the main reason why the falling pound did not lead to rising exports was short term in nature. The UK is slowly exporting more outside the Eurozone, but our exports to say the BRICS, were so tiny that it has taken time for the rise in exports to become noticeable. But the fact is that for the last couple of years export growth to China, for example, has exceeded import growth.

Ditto regarding integration within the supply chain. If it is the case that multinationals find it difficult to change their supply chain structure in the short term, this does not mean they cannot change it in the long term. The real hope, however, lies with re-shoring. If it really is the case that companies are beginning to return their manufacturing closer to where their customers are, that will lead to a slow, bit by bit improvement.

In other words, a cheap pound has not benefited UK exporters that much up to now. But that does not mean it won’t do so over the next few years

The last couple of days has seen news on the UK to delight all but the most cynical. Alas it has also seen news to make the cynical look smug, and say ‘I told you so’.

The good news relates to trade. Exports of goods in the second quarter of 2013 reached £78.4 billion, the highest on record. Okay, imports were up too, rising to £103.3 billion, the highest level since the three months to November 2011. But when it comes to records, ‘best ever’ would normally be seen to score the ‘best in 18 months’.

The UK’s deficit in goods and services in June was £1.5 billion, the lowest deficit since January.

But the real encouragement relates to exports outside the EU. In June exports of goods outside the EU rose, while imports fell. In fact exports to non-EU countries increased by £1.3 billion (10 per cent) to £14.2 billion and imports from non EU countries decreased by less than £0.1 billion (0.2 per cent) to £16.8 billion.

Within the EU, exports of goods also rose, but not by as much (£0.9 billion or2.3 per cent), while imports increased by £0.3 billion or 0.6 per cent to £52.9 billion.

In Q2, UK exports to the US rose by £348 billion while imports were £96 billion, and exports to China were up £153 billion while imports shrunk by £17 billion. The rise in UK exports to China seems to be part of a trend. They have risen sevenfold since 2002.

Don’t over-egg the trade data; it is good, but not brilliant. It is encouraging, however.

Less pleasing was data compiled by the House of Commons Library at the request of the Labour Party. It found that since 2010, of the 27 countries in the EU only three have seen real wages (that’s wages after inflation) fall so steeply. It turns out that UK wages, after inflation, have fallen by 5.5 per cent since 2010. Only in Portugal, Greece and Holland have wages relative to inflation fallen more than that.

Those two sets of data show the two sides of the UK economy at the moment. There are signs, albeit not overwhelming signs, of exports leading recovery. But as long as wage rises continue to lag behind inflation, the UK’s economy looks fragile. Much of the growth we are seeing is coming on the back of consumers spending more, which itself occurs because they are once again running up debts.

The fix lies with getting productivity up, and that surely depends on more investment. That is why George Osborne’s approach to creating growth via rising house prices is dangerous, but we don’t seem to have learnt from past lessons.

Not enough investment and rising house prices were characteristics of the UK economy before 2008. They are becoming characteristics again.

The pound fell to a three year low against the dollar last week, and predictions of doom emanated from the UK’s more cynical press. ‘Oil will go,’ they cried, ‘the cost of holidaying abroad will shoot up,’ they moaned, ‘oh woe is us,’ they lamented. There are indeed strong disadvantages to having a cheaper currency. But there are advantages too, and there are reasons to think that the pound may fall a lot further yet – at least relative to the dollar.

There is one thing that Mark Carney, the Bank of England’s new governor, and Haruhiko Kuroda, the newish governor of the Bank of Japan, have a lot in common. Actually they probably have a lot in common but let’s just focus on this one obvious point today. They both seem to be in the process of enacting policies to weaken their respective currencies. In Japan where the governor has been in his post for a few months longer, the policy is advanced; in the UK it is only really being hinted at.

But recently Mark Carney made it just about as clear as was possible. Even if the Fed starts to tighten monetary policy sooner rather than later, and the dollar rises as a result, putting the pound under pressure, the Bank of England will not necessarily follow suit.

The pound fell sharply on the news. At one point last week there were less than 1.49 dollars to the pound. That was a three year low. But then Fed chairman Ben Bernanke appeared to do something of a backtrack, and the pound rose back up, finishing last week with an exchange rate of 1.51, which actually was nothing out of the ordinary – not over the last year or so, anyway.

It may be worth making a few comments at this point. Firstly, the Fed’s attempt to clarify last week, and reassure us about monetary policy was about as unambiguous as a disco dancing sloth. Frankly, Bernanke didn’t really appear to say anything new, and it is clear that opinion is divided amongst his colleagues at the Fed. The timetable for the Fed tightening its policy – namely reducing QE later this year, removing it altogether next and upping rates in 2015 – seems to be unchanged. But because Ben used some nice reassuring words, the markets seemed to love his comments. Equities lifted, pushing the Dow and S&P 500 to new all-time highs and alleviating pressure on the pound, as they somehow concluded that there was something new in the Fed’s words and that monetary policy will not be tightened as quickly, after all.

Secondly, the pound may have fallen against the dollar, but the UK press missed the wider story. This was not so much a case of a falling pound as a rising dollar. The euro pound exchange rate has done nothing spectacular. However, look deeper, and it appears there are reasons to expect sterling to fall.

For one thing, a comparison of UK unit labour costs with the rest of the world suggests sterling is overvalued. The real effective exchange rate (based on IMF data) is 7 per cent above the level seen in the mid-1990s and 20 per cent above the level in the mid-1970s, or so says Capital Economics.

For another thing, something a little disturbing has happened to the UK’s balance of payments. We are used to seeing a deficit on trade in goods and services, but at least income from investments flowing into the UK tends to be greater than income flowing abroad. But there are signs that this is changing. The UK’s net investment income has been negative in three out of the last four quarters. The story here is complicated. The value of investments held by foreigners, but relating to the UK, is much greater than British investments abroad. But UK investments held abroad tend to be higher risk, and generally provide a much higher return. There are signs that this is changing, however, and that is a worrying development. To be clear, if net investment income continues to be negative this will put pressure on sterling relative to most foreign currencies, not just the dollar.

While is it the case that the real currency story of the last few weeks has been one of the dollar versus the rest of the world, across much of the global economy central banks have responded by upping interest rates themselves. For example, they rose last week in Brazil. China’s central bank is tightening, and rates were recently increased in Indonesia. The story is not clear cut – these things never are, but as rates rise in the US, leading to a stronger dollar, many other countries will probably follow suit. If the UK and Japan loosen monetary policy at such a time, they will be in the minority putting both the yen and sterling under pressure against a basket of international currencies – not just the dollar.

On the other hand, the prospects for the UK economy have been improving of late, and it would be odd if sterling tumbled just as UK plc began to show signs of pulling out of its downturn.

But supposing it happens and the pound falls much further, what then?

At a time when there are signs of improving exports, especially to the US and outside Europe; at a time when some anecdotal and some hard evidence (see car exports) points to a mini renaissance in the UK manufacturing industry and its exports, a cheaper pound will give exporters even more of a lift. On the other hand, a falling pound may lead to rising inflation, and in this respect the UK has previous. Think of 1967 and the pound being devalued and the then Prime Minister Harold Wilson saying it will “not affect the pound in your pocket.” In fact sterling’s devaluation did – UK inflation shot up soon afterwards.

And that brings us to the UK’s big dilemma.

Yes we need exports to help lead recovery, but we also need increases in average wages to start outstripping inflation again. A cheaper pound may help us achieve the former, but most certainly not the latter.

What the UK really needs is productivity to rise, and that needs more investment; more investment in business, in entrepreneurs, infrastructure and education – and, it may seem like a cliché, investment in education in creating more engineers, because that is where the real labour market shortage is likely to be.

If UK consumers open their wallets and purses and start spending in any significant way soon something is wrong. But there are reasons to think that exporters and investment may lead the UK forward. This is where we enter a danger period. A recovery built on correcting imbalances will be a good thing. But recovery built on consumer debt, as rising house prices encourage them to go out and buy, would be most worrisome and may even give credence to the prophets of doom.

The truth is that growth in UK wages has been lagging behind inflation since the beginning of 2010. Savings have been much higher too. In the second quarter of 2008, the UK was entering recession, but at that point economic forecasters had not woken up to this, and many were still forecasting a mild slow down. During this quarter the UK savings ratio was just 0.2 per cent.

This was surely evidence we had entered a time of madness. But a year later, the savings ratio had risen to 8.6 per cent. That was a staggering rise. UK households, scared by the prospect of falling house prices, had hit a big red button with the legend danger emblazoned on it. They saved more, and soon after, their wages fell.

So what do you get when consumers spend a lower proportion of their wages, while wages relative to inflation fall? Answer: a very severe dip in spending. No wonder the recession was so severe.

But the solution to this problem is surely not to encourage households to save less and borrow more. It is to try to get wages to rise, and for business and the government to use the money that households are saving to fund investment. At the same time, UK company profits are surging, and corporate cash sitting in deposit accounts at UK banks has hit 25 per cent of GDP, which is a 25 year high.

The UK can go one of two ways. The money that is not being spent, and is instead sloshing around the banking system, could be used to fund mortgages and in turn create a housing boom. Writing in the ‘Telegraph’ recently, Jeremy Warner said: “UK housing was not the cause of the financial crisis; in fact, UK mortgage lending has remained a haven of calm and safety for the banks throughout the storm.” See: Unbalanced and unsustainable – this is the wrong kind of growth

Maybe he is right, but isn’t that the problem. For too long, whatever money that is available has been used to fund mortgages, even buy-to-let mortgages because they are seen as safe, instead of funding entrepreneurs and wider investment because this is seen as risky. Even many would-be entrepreneurs have been seduced by the allure of easy and low risk money from buy-to-let, and have left the path of wealth creation and joined the path of re-shuffling wealth, which is all that buy-to-let achieves.

If the UK goes down the path of creating a housing boom, the causality may be true entrepreneurism and a boom based on debt rather than productivity. Alternatively, if savings were used instead to fund investment, the result would be truly exciting.

Despite George Osborne’s efforts to administer the first of the alternatives – the cheap and easy way to growth, election victory and an unsustainable economy in which falling government debt is paid for by rising household debt – there are signs that the second approach is occurring anyway.

The UK’s export recovery has been held back by the rather unfortunate fact that the Eurozone, our largest trading partner, is in the midst of an economic depression. But since 2002 exports to China have risen sevenfold. According to a report published by the ONS a few days ago: “In the latest three months the value of exports was 17 per cent higher than the average 2012 quarterly level. Import values from China were little changed, so the trade deficit with China, which had averaged £5.2 billion a quarter in 2012 shrank to £4.8 billion in the latest three months.”

Just as is the case in the US, there are also signs of manufacturing led recovery. UK car exports are beginning to outstrip imports. There is also anecdotal evidence of companies returning their manufacturing to the UK. As Capital Economics said: “The decline in offshoring has reflected a variety of factors. For a start, the trend towards more capital intensive production as technology improves means that the savings in labour costs that can be achieved by switching production to Asia have become a smaller component of total costs.

Western manufacturers are also increasingly specialising in high-tech sectors in which production cannot necessarily be replicated elsewhere. The strengthening of Asian currencies has also reduced the savings from offshoring. In addition, fast supply chains are increasingly valued, so that production can respond quickly to consumer tastes and inventory costs can be reduced. “

As for the UK, it said: “According to the manufacturers’ organisation EEF, the proportion of firms repatriating some output rose from 15 per cent in 2009 to 40 per cent last year.” It continued: “Low-value sectors such as textiles have been declining, while high-value markets such as pharmaceuticals and transport have been growing rapidly. The destination of UK manufacturing exports has also evolved. The share of goods exports going to the fast-growing BRIC economies increased from 5 per cent in 2007 to 8 per cent last year and has also persuaded some firms to produce domestically.”

There other reasons to be optimistic. Demographics are looking favourable. Population growth in the UK in this decade is likely to be at its fastest rate since the first decade of the 20th century. The shortage of homes to population is a problem, but there are signs this may be fixed as the government tries to reform planning laws. A house price bubble will do little for the UK in the long term, but a house building boom is different thing altogether, and this may happen.

North Sea oil output is on the rise again, and the shale gas revolution may or may not be a mixed blessing, but it should at least help to promote growth. And don’t forget that in a growing global economy the UK has certain innate advantages: its time zone being one. The UK working day overlaps with working days in both California and East Asia. The fact that English is spoken rather widely in the UK is another advantage. Add to that political stability and a strong legal system.

Yet, for all that optimism, something broken remains. The UK is not well disposed to encouraging risky investment. That may not sound like such a bad thing, but remember that risk is the key to innovation and growth in the long run.

The government can do more to help and it could start by using money created by the Bank of England via QE to directly fund investment into infrastructure and in entrepreneurs.

The pound fell to a three year low against the dollar this week. At the time of writing there are 1.4949 dollars to the pound, and many have hit the panic button. They say a crash in sterling is in sight. Are they right?

The current dollar pound exchange rate is low, but it’s far from being a record. It was lower in 2009, and in the mid-1980s went close to parity with the dollar. There are two reasons to fear for sterling, and indeed the consequences of a fall in the pound. But there are reasons for less pessimism, indeed even optimism too.

Reason number one is the Fed. If good news on the US economy continues it has said it will start cutting back on its quantitative easing programme this year, halt it altogether next year, and up interest rates in 2015. If this is indeed how it pans out, as US rates rise, money might well flow into the US from the rest of the world. Many central banks may respond by upping rates.

Because of the high level of household debt we can’t really afford higher interest rates in the UK. The Bank of England may have to choose between upping rates to stop a rout on sterling, but creating massive hardship for households with high debts in the process, or just accept a much cheaper pound relative to the dollar. Just bear in mind, however, that this problem is not unique to the UK, and if rates rise in the US, the pound may fall relative to the dollar, but stay firm relative to other currencies, such as the euro.

Reason number two is more serious. In the UK we are used to imports of goods and services being greater than exports, but at least income from investments flowing into the UK tends to be greater than income flowing abroad. But there are signs that this is changing. The UK’s net investment income has been negative in three out of the last four quarters. The story here is complicated.

The value of investments held by foreigners but relating to the UK is much greater than British investments abroad. But UK investments held abroad tend to be higher risk, and generally provide a much higher return; there are signs this is changing, however, and that is a worrying development.

To be clear, if net investment income continues to be negative this will put pressure on sterling relative to most foreign currencies, not just the dollar. On the other hand, a cheap pound may be good for exporters, although it will be bad for inflation, and may extend the period of time in which wage increases lag behind inflation.
But this may not occur, not at all.

Take the latest trade data. In the latest three months the value of exports to China was 17 per cent per cent higher than the average 2012 quarterly level. Import values from China were little changed, so the trade deficit with China, which had averaged £5.2 billion a quarter in 2012 shrank to £4.8 billion in the last three months.

Historically, the UK runs a trade in goods surplus with the United States. That rose in the latest three months. The value of exports was 5 per cent higher than its average 2012 level, while imports fell by 8 per cent. In the three months to the end of May, exports to non-EU countries increased by £1.7 billion while imports increased by £0.9 billion.

There is one big danger however. The UK does suffer from a disease. For too long money has flowed into supporting the housing market – though not house building – but there are few signs this is changing.

Remember, the strength of sterling tends to tell us how strong the economy is. If the economy does well sterling usually rises. In a way, the value of the pound is like the UK’s share price.

Right now, company cash holdings sit at around 20 per cent of GDP or at a 25 year high. If this money is used to fund investment, then the UK may boom. If instead, companies hoard their cash, banks focus on parking cash sitting in deposit accounts in mortgages, and the government focuses on trying to get house prices rather than investment up, the UK’s share price – or if you prefer to put it these terms, the value of the pound – will come under new and prolonged pressure.